Trust accounting, at its core, is the same for non-profits, estates, and businesses. However, to properly and legally handle owner and tenant funds, a property manager must understand the basic principles of trust accounting for the rental industry.
Important: Trust accounting regulations for property managers are area-specific so it is highly important to consult your state and local requirements for compliance.
What are Trust Accounts?
A trust account is different from a regular business bank account in that the funds in the account do not belong to the one managing that account.
Simply put, money is held in a specialized account and are managed on behalf of others (the beneficiaries). Or in technical terms, a manager is operating in a fiduciary relationship with the beneficiaries of those funds.
How are Trust Accounts Different for Property Management?
Trust accounts for property managers are designed to be used to keep tenant deposits and rent payments separate from the property management business operating account.
The funds in the trust account are considered to be client funds (the property owners) and not funds of the brokerage (property management company). In a property management trust account, the property owners are the beneficiaries. That means the property owners benefit from the property management (trustee) oversight of those funds.
Important: The proper handling of tenant rents and deposits with good bookkeeping practices is important to avoid commingling of funds; which is illegal.
It’s important to have a good management agreement in place when dealing with owners and their funds. Some states require property managers and owners to specify in the management contract exactly how trust accounts will be used. In addition to discussing management fees, other actions should be addressed in that agreement such as:
- What types of expenses are paid for with those funds?
- How tenant security deposits are held and returned?
- What amount of rental income is held back in property reserves for emergency and routine maintenance?
- When are owner disbursements calculated and processed?
- What are the procedures for events such as the sale of the home to another owner, tenant abandonment expenses, natural disasters?
Important: Even if there are no state regulations, it is always good practice to identify specifics in your management agreements.
The Three Big Concerns | Audits, Insurance, and Judgements
Trust accounting, when done correctly, addresses the three biggest concerns when handling other people’s funds.
In California, audits from the State Board are very common and routine but in many states they are random. Whether something you face often or rarely, audits don’t have to be a frightening event. Trust accounting prepares property management companies for whatever oversight occurs.
What happens if a bank fails due to a crash in the economy? All business accounts under one tax ID are collectively insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC). That means, if the accounts are not set up as trust accounts, no matter how many accounts are under that tax ID will only receive one max reimbursement.
As trust accounts have beneficiaries, each beneficiary is covered by the FDIC. What does that mean for the property management company and their clients (owners)? It means that if the bank account is set up correctly as a proper trust account, funds for every owner (beneficiary) are protected up to $250,000.
Heaven forbid a property manager or management company receives a judgment against them directly. The good news is that if your accounts are proper trust accounts, they will be safe from being frozen by any judgment against you or the business as those funds are not yours nor belong to your management company.
A regular business account would be subject to an account freeze; which would halt your ability to collect rent, pay expenses, and disburse to owners. In effect, it could ruin your business or at minimum cause damage to client trust.
What About Security Deposits and Operating Accounts?
Depending on your state guidelines, a property manager can set up one aggregate trust account or separate accounts for each owner. If not regulated, it is up to the property manager to decide between one or multiple accounts for accounting and tracking purposes.
Some rental management companies choose to set up two accounts – one established as an operating trust account and one to serve as a tenant security deposit trust account. This often is a recommended practice so you don’t accidentally spend the security deposit funds.
These trust accounts are separate from any business checking or savings account you open to manage your property management company income and expenses. Again, keep all these accounts and funds separate to avoid commingling funds. A good property management software will be your biggest support in helping you with those bookkeeping tasks and compliance.
Questions to Ask Your Banker About Trust Accounts
First, before asking your bank any questions about trust accounts, get familiar with your state regulations on the subject including if you can hold trust funds in an interest or credit-bearing account. With that information at hand, speak to a chief risk manager or an accounts manager. Two important questions for new accounts would be if they:
- Have experience with the set up of trust accounts for property management companies?
- Offer credit or interest-bearing trust accounts? If your state allows, credits and interest-bearing accounts are a great way to off-set bank fees and invoices!
For current account holders, it is important to verify that your accounts are not just simply nicknamed ‘trust account’. This is very important as the bank account representative who set up your account might not have been familiar with property management trust accounting activation. Remember, a proper trust account protects all of your clients’ funds and is not subject to judgments against you or your business that may freeze a regular bank account.
Keeping Your Trust Accounts in Compliance
The biggest red flag during a property management company audit involves improper handling of trust funds. Those red flags come up when auditors review the transaction types and timing as well as reports and reconciliations.
One of the most serious misuses of a trust account involves the commingling of owner and manager funds. Depending on your state laws, different acts can be considered commingling such as:
- Personal or company funds are deposited in the trust account
- Trust account funds are deposited in a business or personal account
- Commission fees/ management fees are left in the account for a longer period of time than what is legally allowed
- Rent or security deposits on the broker-owned property are placed in a trust account
- The property manager conducts personal business from the trust account
- One client’s funds are used for another client’s property
- Tenant security deposits are used to cover operating expenses
The rules, regulations, and customary practices vary wildly across the country and between states, so make sure you are familiar with your state’s specific laws.
Deposit Regulations and Timing
One of the most problematic requirements of trust accounts on how quickly the funds must be deposited. A real estate commission regulation may require funds to be deposited by the close of the next business day.
Consider using online payment processing (ACH) that is integrated with your property management software to avoid handling checks and making those deposit date deadlines.
Of course, accurate and timely bookkeeping is important but also remember to reconcile all your accounts on a timely basis to avoid any future discrepancies.
Regulations also specify how long records of trust account transactions must be kept.
To protect yourself and your business, it is important to keep any paperwork that might be necessary to defend yourself in the future should you face an audit or a legal battle.
Important records include (but are not limited to):
- Past and present management agreements
- Past and present lease agreements
- Checkbooks and checkbook registers for all accounts
- Record of all checks issued, including voided checks
- All bank statements
- All deposits
- Access to your bookkeeping system, such as your property management software
- Copies of all financial reports that have been provided for your owners
- Invoices paid to vendors
- Records of all security deposit refunds
Pro Tip: To help you be audit-ready and in compliance, consider conducting periodic internal audits.
Benefits of Using Trust Accounts
Your clients are trusting that their assets and funds are in good hands. When in compliance and set up correctly, the owner’s funds are properly insured and protected against any possible judgments against you or your business. You will have peace of mind if and when an auditor asks for your time. Keeping those accounts and records well-maintained adds to your overall professionalism and reputation.
The right trust accounting software for property and tenant accounting can be an extremely helpful tool for you to stay in legal compliance, keep funds separated, and increase audit readiness. Just as important as the right software, be familiar with state regulations, make sure your bank accounts are set up properly, and be sure your records are in good order so if you happen to be audited you will be ready.
*This article is intended to provide an overview of general practices for managing trust accounts and should not be taken as legal advice.